Stocks surge on economic data, higher oil prices

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. – Warren Buffett

In a sign that this promises to be a volatile year for the stock market, the S&P 500 Index recovered all that it had lost the previous week as it jumped 3% on positive economic data and stabilizing oil prices. For the second consecutive week, oil prices rose and finished the week at over $50 a barrel, an encouraging sign that the global economy is not as weak as many had thought. Oil inventories are at record high levels that have not been seen in eighty years. With an abundance of oil pushing the price down, a slight rebound in prices coupled with stability of those prices could give investors confidence that demand may be improving. Investors were also given some favorable news on the economy last week as the employment report was better than expected. The U.S. created 257,000 new jobs during the month of January and the number of new jobs was revised significantly higher in the two previous months as well. While the unemployment rate ticked higher to 5.7% from 5.6%, the reason for the slight increase was a higher participation rate among unemployed workers. This increase should be viewed positively as more people entered the workforce in search of a job. Hourly earnings also posted the largest gain in over six years, suggesting that private-sector workers will have more spending power and that deflationary fears will abate. If this upward trend in wage growth continues and oil prices stabilize at relatively low levels, workers will undoubtedly benefit from having more money in their pockets and the economy should benefit as that money is spent. This good news does come at a price, however, as job and spending cuts have yet to be felt in the oil industry. These cuts are likely to occur in the next several months as oil producers adjust to lower energy prices.

Last Week

Although the January employment report was positive news for the economy, other economic news last week was less encouraging. Both the January ISM manufacturing index and December construction spending were weaker than expected and factory orders in December posted a bigger than expected decline. Incomes posted a solid gain in December but consumer spending recorded its biggest drop since September 2009 as workers chose to save more of their income. Jobless claims rose last week but less than expected and U.S. productivity fell 1.8% in the fourth quarter.

Greece continues to develop a plan that will appease its creditors while the European Central Bank (ECB) gave Greek banks approval to borrow emergency funds from the Greek central bank. Whatever should happen down the road, Greece is being viewed as an isolated case that will not spread to the rest of Europe.

For the week, the Dow Jones Industrial Average climbed 3.8% to close at 17,824 while the S&P 500 Index jumped 3% to close at 2,055. The Nasdaq Composite Index added 2.4% to close at 4,744.

This Week

There are only a handful of economic reports to be released this week and the most important of those is January retail sales, which is expected to fall 0.5% due to plunging gasoline prices. Core retail sales, though, could actually rise 0.5% and offset the steep decline in December.

Several key meetings are scheduled this week, including one between German Chancellor Angela Merkel and President Barack Obama to discuss the situation in Ukraine, and a meeting of Euro-zone finance ministers to address Greece’s debt crisis.

Among the blue chip companies on tap to report quarterly earnings results this week are Coca Cola, PepsiCo, Kellogg, Whole Foods Market, CVS Health, Time Warner, Applied Materials and Cisco Systems.

Portfolio Strategy

With the S&P 500 Index rallying last week to recoup all of the previous week’s losses, the stock market appears to be range bound between 1990 at the low end and 2090 at the upper end. The all-time high for the S&P 500 was 2090 set back on December 29^th. For the year, this broad-based index is roughly back to even after spending almost all of January in the red. For the most part, fourth quarter corporate earnings have been better than expected, although expectations had been reduced and earnings had a lower hurdle rate to overcome.  News last week that Pfizer would acquire Hospira for about $16 billion could be a propitious sign that more mergers and acquisitions are in the works as companies seek ways to grow their business. Worries about a slowdown in demand have caused companies to reduce capital expenditures and business investment in favor of stock buybacks and dividend increases. While buybacks can serve the purpose of increasing earnings per share by reducing the number of shares outstanding, they cannot sustain earnings forever and are a poor substitute for investing in future growth. Since large multi-national companies found in the S&P 500 Index are adversely affected by a strong dollar, small cap stocks that sell domestically might have better earnings growth prospects and outperform large cap stocks. After trailing the S&P 500 Index during the past year, the Russell 2000 Index of small cap stocks could turn the tables and surprise investors this year.